Cost Management

CFOs guide to cost optimization

Don’t just cut costs—optimize them.
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Amelia Kinsinger

· 3 min read

Often, organizations make reactive cost cuts in response to economic pressures. Ad hoc cost cuts can help organizations stay afloat in the face of unexpected events such as the Covid-19 pandemic. But such cuts are usually a short-term fix, and they do little to drive value.

Though emergency cost cuts may sometimes be necessary, best-of-class organizations prefer to handle cost reduction in a proactive, rather than reactive, manner. They practice what’s known as cost optimization: a disciplined, strategic approach to cost management that includes reinvesting cost savings back into the business to help it grow.

What is cost optimization?

Cost optimization is a method of balancing an organization’s need to trim costs and spending against its desire to grow. It involves assessing costs and spending, identifying areas that can be cut or streamlined, and using those savings to fund further growth. This process takes place continually, not just during budget season.

In fact, cost optimization is as much a mindset as it is a process. Organizations that practice it must expand their definition of “value” to encompass not only profit but also intangibles such as reputation, brand, and customer experience. Often, they reassess their approach to cost as well, thinking of costs not in terms of specific targets or dollar amounts but in terms of yields.

They must also take a longer-term view of cost reduction. Cost optimization efforts typically take two to three years to produce results.

There are many different ways to optimize costs. Some examples might include renegotiating contracts with suppliers to get better terms, automating and digitizing processes, standardizing procurement, eliminating maverick spend, and simplifying your tech stack.

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Best practices for cost optimization

Finance teams should not share the sole responsibility for cost optimization. In fact, cost optimization is often most effective when it’s cross-functional.

Cost-management frameworks are a useful tool for standardizing cost optimization and implementing it organization-wide. They can help ensure all business units have a shared definition of cost and value, and are prepared to participate in the cost optimization process.

Cost-management frameworks differ, but they often consist of a chart or grid where teams can list proposed cost-reduction measures and rank them in terms of their benefits, impacts, and risks, any investments required to implement them, and how long it will take them to produce savings.

Another best practice for effective cost optimization is to set goals and communicate these goals across business units. This is one area where many organizations have room for improvement: Only 48% of companies set clear measures of success for cost management, a Gartner survey found.

Cost optimization in IT

You’ll often see the term “cost optimization” used in an IT context. (In fact, cost optimization is one of the six pillars of Amazon Web Services’s Well-Architected Framework.) As technology forms such a large piece of many organizations’ budgets, it’s an area ripe for both cost savings and investments that can drive value. Finance teams should collaborate closely with IT leaders on ways to reduce IT spend as well as digitize processes to make them more cost effective.—CV

News built for finance pros

The latest news and insights corporate finance professionals need to know to keep up with their constantly evolving industry.